MEPs: Green finance good, sustainable finance better

As the European Commission is finalizing the last set of legislative proposals that can still be completed before the European Parliament elections, MEPs today adopted a non-legislative report in ECON calling for a more ambitious strategy on sustainable finance. MEPs support the criticism that the Commission’s Action Plan on Financing Sustainable Growth is too narrowly focused on climate change and should support a wider European agenda on long-term sustainable financing of the European economy.

Highlights from the report (due to be published later this week, compromises available here) include a call to address the full range of Economic, Social and Governance (ESG) issues beyond climate change, better transparency for retail investors and recognizing their investment preferences, capital adjustments reflecting financial stability risks, and more ambitious labelling of green bonds and retail investment products.

The report must still be confirmed in plenary but this should not lead to major changes; the real next step is expected from the Commission on 23 May, with its final legislative package on financial services before the 2019 election break.

Full summary:

The Parliament reminds the Commission that dealing with climate change is not sufficient, and that environmental issues are closely related to the economic and social challenges of society (Recital A). “Sustainable finance goes beyond climate and green investments and should quickly also take social and governance criteria on board” (Recital Aa). The future EU taxonomy on sustainable finance should reflect that (Article 6).

As long as the timeline is sufficient, all ESG-related risks are financially material, as political or reputational risk might materialize only in the very long term. MEPs are clearly aware of such reputational issues and generational change, recognizing that there is a new generation of investors (the millennials but also others) who are amongst the retail investors showing “increased interest in products observing ESG criteria’ (Recital Bb). EuroSIF’s annual survey of Sustainable and Reponsible Investment also shows an increase in all types of sustainable (ranging from ESG-screening to impact investing). Unfortunately, there was no majority for mandatory disclosure of ESG impacts in all investment products on this occasion (Article 9) — the Parliament retains its PRIIPs position that greenwashing should be prevented by requiring those who claim positive E&S impacts to demonstrate this.

As more and more national supervisors recognize the potential systemic risk of stranded carbon assets, MEPs explicitly endorse the ESRB’s 2016 call for carbon stress tests and “capital adjustment” for carbon-intensive exposures, also known as a “brown factor” (Article 3). They also warn that green investments should not be stimulated using capital requirements that deviate from a risk-sensitive framework (Article 8), call for the ESAs to provide guidance (Article 17), and urge the EU to get its own house in order and stop stimulating EIB and ECB activities that are detrimental to combating climate change (Article 18 and 19).

The Green Finance Mark (Article 5) is Parliament’s response to the Commission’s thinking on green bonds and retail “eco-labels”. MEPs call for a labelling system that combines both minimum standards (including a do-no-harm principle on a broad ESG basis) as well as a scaled rating rather than a binary label (i.e. much like energy efficiency labels on electronic household appliances, rather than the organic food label or cleaning product Eco-label). Such an approach would avoid stimulating investments that do well on environmental parameters but are damaging to other aspects of sustainable investing, such as biofuels. More mundane green bonds should be subject to stricter rules to avoid “misleading marketing” and support a decrease in the use of fossil fuels (Article 14).

According to the Parliament, the more fundamental review of the Non-Financial Reporting Directive (NFRD) due in 2019-2020 should be used to move towards “proportional and gradual” though mandatory disclosure of non-action on climate, environmental and other sustainability risks (Article 9 and 13). Note that the Commission initially is planning an update of its NFRD Guidelines, released only June last year.

One of the few areas where this own-initiative report can still influence the legislative package due on 23 May 2018, is the forthcoming investor (fiduciary) duties proposal. In Article 10, MEPs show the Commission what that proposal should look like, or will look like after being amended by the European Parliament: both financially material ESG factors as well as non-financially material ESG preferences should be integrated in decision-making.